Production Possibilities Curve July 29, 2008

This model explains the concepts of scarcity, opportunity cost, trade-offs and overall production possibilities between the use of a resource for one alternative or the next.

Any increase in production of one good using current resources will decrease our ability to produce another good because of the scarcity of resources, There are three types of production possibilities curve:

1. Concave or bowed out PPC which occur when opportunity costs increase as you move to increase production of one good. Example: In order to produce an additional unit of capital goods, we must forgo the production of two consumer goods, yet another additional unit of capital goods will cause three units of consumer goods to be forgone.

2. Constant or straight line PPC exhibits a constant opportunity cost as you increase production of one good. Example: To produce one capital good will have an opportunity cost of two consumer goods. The next unit of capital goods produced and each subsequent capital good will have the constant opportunity cost of two consumer goods.

3. Convex or bowed in PPC (a rare occurrence) will have with each increase of one good a decrease in opportunity cost of the good forgone. Example: In order to produce an additional unit of capital goods, we must forgo the production of two consumer goods, yet another additional unit of capital goods will cause only one unit of consumer goods to be forgone.

PPC’s and Efficiency:

Any point on a PPC is completely efficient, meaning that there is an absence of waste.
A point inside the curve represents a misallocation of resources and is inefficient.
A point outside the PPC can only be reached through improvements in technology or increased resources.

For a more thorough explanation of the PPC, refer to Reffonomics:
Part I – Part II – Part III – Part IV

Economic Systems July 29, 2008

Every economy must answer the three questions:

1. What to produce?
2. How to produce it?
3. For whom to produce?

Economy’s can answer these questions through three basic systems.

Command Economy – Command economies answer these questions through centralized planning, often government intervention and regulation.

Traditional Economy – Traditional economies answer these questions by following past customs accepted by society.

Market Economy – Market economies allow supply and demand to arrive at an equlibirum price which allocates the goods and services.

David Ricardo’s Comparative Advantage Theory July 29, 2008

David Ricardo’s comparative advantage theory is the greatest academic argument for the benefits of free trade. His theory is so relevant to the exponential growth of globalization and free trade that we are experiencing in today’s world. It has brought many people across the globe out of poverty, but has also brought us the secondary effect of a deteriorating environment.

Comparative advantage proves that voluntary trade between partners will undoubtedly cause increases in production for both sides, even if one side has the absolute advantage in productivity in both products.

For more informtion and a more thorough explanation on comparative advantage, see the video below.